This was the
title of the workshop presented as part of the 'Seminario Internacional
de Macroeconomia Para o Desenvolvimento' (International Seminar on the
Macroeconomics of Disinvestment) at the Federal University, Rio de Janeiro,
Brazil, on 29 January, 2003.
The workshop was presented by 'O Instituto de Economia da UFRJ' (Institute
of Economics, Federal University, Rio de Janeiro) and IDEAs (International
Development Economics Associates).
The workshop, which was presided over by Franklin Serrano (UFRJ, IDEAs),
had three sessions-two in the morning and one in the afternoon. The first
session concentrated on theoretical problems regarding free capital flows,
and the second on international experiences. The afternoon session focussed
on the economic policies of Brazil. The audience mainly comprised people
with an academic background, the majority being students and teachers
of economics.
Franklin Serrano, as the first speaker at the first session, offered an
analysis and critique of the bi-polar exchange rate regime. Though the
bi-polar vision has suffered a disaster in recent times, modern economic
theory has been unable to bridge the gap. Given the recent developments
in developing economies and the tendency for central banks to fix an internal
rate higher than the equilibrium so as to attract foreign capital, the
existing fixed and flexible exchange rate models do not work any more,
and fiscal and monetary policies have lost their uses as described in
traditional theory.
At a theoretical level, Serrano explored the Mundell–Fleming model
with a different interest rate treatment. The use of exchange rate devaluation,
under a floating exchange rate regime, as a mechanism for adjustment tends
to lead to worse devaluation as it adds to the internal–external
gap. Earlier, the speed with which the capital account adjusted was always
slower than the speed with which the commodity account adjusted. Now,
with capital mobility being very high and with the increase in importance
of short-term capital, there is no time-gap or lag between commodity and
capital account adjustments. Movement from a fixed to a flexible exchange
rate regime does not essentially address this problem. So, moving from
one to the other does not solve the problem that free and fast capital
mobility imposes on the economic system. The solution, Serrano suggested,
is to take things slowly and not go in for drastic and hasty financial
liberalization.
The next speaker, Prabhat Patnaik (Jawaharlal Nehru University, New Delhi,
India), highlighted the fact that a major fallacy of neoliberal policies
is the failure to distinguish between stock and flow decisions. The fact
that individuals make a concrete decision regarding the form in which
to hold their savings has been ignored by neoliberal economists since
they work with an implicit assumption of full employment where all savings
are invested. Under this assumption, a higher interest rate is said to
automatically lead to higher savings and therefore higher investments.
Simultaneously, given a savings schedule, increase in public investment
actually crowds out private investment by adjusting the interest rate,
keeping employment (already full) unchanged.
Patnaik suggested that this idea is fallacious because savings and income
(Y) change simultaneously and therefore assuming a fixed savings pool
and fixed (full) employment is erroneous. With fiscal policy, it is possible
to increase savings, and therefore employment. Neoliberal economics needs
to recognize that stock and flow decisions simultaneously determine equilibrium
savings and investment.
Governments in developing countries, urged Patnaik, should go in for expansionary
policies like distribution of foodgrains stock, expansion and utilization
of industrial capacity, rather than let the private sector replace its
activities.
In the context of free capital flows, the Mundell–Fleming model,
for example, had suggested that interest rates would be equal everywhere.
But, Patnaik pointed out, in reality this is not so, since capital always
prefers to go to the north rather than to the south. Therefore, the south
always has to pay a premium on its interest rate. A higher interest rate
will tend to reduce private investment. It will also make government borrowing
unsustainable if the growth rate is lower than the interest rate. Therefore
government expenditure has to be reduced, and government investment and
subsequently the growth rate will fall, as will private investment. An
additional problem is that the rate of interest never, by itself, determines
capital inflow.
In any case, increased capital flow has its own problems. Higher capital
flows may go towards replacing domestic private sector investment, that
is, it may actually cause domestic deindustrialization. If this capital
inflow can be used to finance private domestic or government investments,
there would not be a problem. But usually this does not happen. In addition,
borrowing short-term funds for financing long-term investments is quite
unlikely. Further, the fact that foreign exchange reserves will also be
used up might mean heading towards a crisis in the long run.
On the other hand, under a flexible exchange rate, if capital inflow increases,
the real exchange rate appreciates and foreign capital gets a higher return
compared to government investments. This creates contractionary movements
in the economy. But the reverse is not completely true. When capital flows
out the exchange rate does not depreciate so much, since expectations
regarding the real exchange rate going down are much higher as real wages
(and therefore workers' demand) cannot fall so much. So the expansionary
process does not really take place to a large extent and, in addition,
government intervention in such cases may actually set in motion a deflationary
process.
The second session in the morning started off with an introduction to
IDEAs by Jomo K.S. (University of Malaysia, IDEAs). After describing the
organization, its objectives and aspirations, he invited the audience
to visit the official website. He then went on to speak about three issues
surrounding financial liberalization (FL)—first, the consequence
of FL; second, the process by which FL creates a net capital outflow;
and finally, the question of capital management.
The consequences of FL have been many. First, except for brief time-periods
in Asia and Latin America, there has been an overall outflow of capital
from the developing countries. Second, the lower costs of funds that were
promised as a benefit of FL have not been realized. Third, financial deepening
was supposed to reduce risks. This has happened, but because of new financial
instruments, the likelihood of systemic risk has in fact increased. Financial
capital inflow has also generated a strong deflationary impact since capital
inflows are very sensitive to consumer price inflation and therefore governments
have generated a strong tendency to control inflation. However, as country
experiences show, the higher the extent of inflation targeting, the lower
has been the growth rate. Finally, international financial liberalization
has undermined the possibility of development finance that is long-term
in nature.
The phenomenon of net capital outflow that has taken place as a result
of FL has in turn its own sources and consequent complications. Firstly,
asset price bubbles have occurred more, and more but this does not contribute
to development. Secondly, with the availability of cheap credit, consumer
binges by the rich have become a common phenomenon, but again, this kind
of spending is not related to development. Thirdly, there has been a suggestion
that overinvestment occurs as a result of increased availability of capital,
but the speaker did not quite agree with this view. Fourthly, so far the
prudence that has been exercised has meant that central banks have increased
their reserves to offset these flows. So, contrary to common perceptions,
there are no increases in actual stocks.
Jomo went on to stress the need for capital management and detailed the
considerations that should be borne in mind while doing so. First, capital
controls have historically been followed in many countries, and more recently
in Malaysia. Emphasizing the rationale of 'national interest', he pointed
out that in Brazil this was a viable option in the interests of the national
business community. Second, the discussion must now go beyond the realm
of whether to have 'capital control or not', but to 'what kind' of capital
control. Types of capital control, given their historical associations
and therefore the vocabulary used, are very important. The role of political
coalitions or social forces is also crucial in this regard.
Third, the degree of market-friendliness is important. Controls in India,
China and Taiwan Province of China, for example, seem much more market-friendly
and effective compared to those in Chile and Columbia. Fourth, policy-makers
need to differentiate between portfolio flows and FDI, and to encourage
the latter but not the former. The type of FDI also represents an important
policy choice. Fifth, capital controls need to decide whether to control
inflows and outflows, and distinguish between the interests of citizens
and the corporate sector. Sixth, policies regarding mergers and acquisitions
need to be clarified. Finally, structuring exemptions so as to effectively
signal incentives and disincentives is another factor to be taken into
account.
Jomo ended by stressing the need for careful discussions between policy
formulators and people with a detailed and nuanced knowledge of the subject.
Carlos Medeiros (UFRJ, Brazil), the next speaker, discussed the impact
of liberalization on income distribution in Latin America, especially
Brazil.
Latin America was characterized by an acute dollar shortage in the eighties,
which was reversed in the nineties. However, over-availability of foreign
funds actually did not increase economic growth nor did it increase the
stability of the system; rather, it gave rise to higher volatility and
other problems like the import of bubbles and a succession of other investments.
The domestic interest rate was cut to attract foreign capital over this
period.
The effect of all this on income, argued Medeiros, was adverse. Income
growth per capita in Latin America was a low 1.4 per cent, though Chile
recorded higher growth. Productivity and employment growth as well as
the investment ratio were low, with a high disparity between and within
sectors (for example, between agriculture and industry). Over 1990–98,
there was high mass migration from Latin America, especially Mexico, the
Dominican Republic and El Salvador. Both government and private employment
also fell sharply in most countries, including Brazil and excepting Chile.
Empirical analyses, though limited by data constraints, shows that over
this period, inequality increased significantly in Argentina, Chile, Mexico,
Bolivia, Colombia, Peru and Venezuela, while it stayed high but stable
in Brazil. Poverty too increased in Argentina, Mexico and Venezuela. A
hollowing out of the middle earners has been a major trend in all of Latin
America, and is especially intense in Brazil. This reflects the deindustrialization
of labour force. Severe concentration of income at the top is another
major characteristic of Latin America. Real minimum wages at the end of
the nineties was less than that paid at the beginning of the eighties
in all countries in this region, with the exception of Chile, Colombia
and Brazil.
The devaluation of human capital in Latin America was associated with
unstable growth and consumer booms, both of which were a fall-out of the
liberalization process. As a result of the regime of high interest rates,
income has been concentrated in the new rentier class of bond-holders.
There has been a strong polarization process that has created positive
income effects only for the rich and the corporate sector, more importantly.
This has changed the power relations in favour of the private sector as
opposed to the public sector. In the labour market, inequality of distribution
in salaries has come about as a result of increased disaggregation of
the labour market. Public sector jobs and trade unions, on which the middle
and the poorer classes are dependent, are becoming less important. At
the same time, except in telecommunications, other investments have failed
to confer any benefits to the ordinary people.
The next speaker was Reinaldo Gonsalves from UFRJ, Brazil. He discussed
the reasons or needs for using capital control as an instrument of macroeconomic
management, as well as the critical issues that must be kept in mind while
implementing capital control.
First, capital control is necessary for decreasing interest rates in Brazil
and in the rest of Latin America. Second, it is also necessary for controlling
public debt in the hands of non-residents and residents of foreign descent,
because a high public debt ends up in sterilizing public resources. Third,
capital control is the key to long-term development for making available
long-term funds and to keep away external resources from strategic sectors.
Fourth, it is required for preventing domestic savings from going out,
which would have a negative impact on the rate of development. At present
smaller companies are unable to get international funds and also pay a
much higher interest rate, which poses a strategic inconsistency problem
in the development model. Fifth, drugs and arms trafficking have increased
as a result of capital account liberalization, even in Brazil. This issue,
related to political and social parameters, is of great significance,
the speaker emphasized. Cases of corruption and decay in the political
and social system are a fall-out of the present system of financial liberalism.
But while setting up a system of capital control, certain factors need
to be kept in mind. Capital control in Brazil needs to go hand-in-hand
with credit control as a permanent policy. It also needs to be coordinated
with some FDI control. An appropriate mix of macroeconomic policies (fiscal,
credit and exchange rate policies) that are compatible and consistent
with capital control must also be put in place. Simultaneously, a strategic
level of foreign reserves must be maintained for facing crisis situations.
In the Brazilian situation, capital control is a key factor that could
bring forth development and macroeconomic balance. In addition, de-dollarization
of public debt is a very important issue.
Gonsalves placed great emphasis on capital control, since the goods and
services sector is more difficult to control as restrictions there are
perceived as real and strong interference. Finally, the speaker reminded
the audience that international policies and coordination between countries
are very important. Capital control, since it affects the financial elite,
is a difficult political option. It is also necessary to be cautious towards
and discerning of the type of advice that is forthcoming from bodies that
have vested interests, like the World Bank, as well as other forms of
the large economic elite.
In the afternoon session, Fernando Cardim de Carvalho of UFRJ focussed
attention on the economy of Brazil. He started off by discussing how the
question of 'imposition' of capital control, as opposed to the removal
of existing controls, is a very tricky one, since the very mention tends
to trigger off adverse economic behaviour. There is also a great difference
between the formal impact of capital control and its real effects.
Moving to Brazil, he discussed how the Brazilian economy is supposed to
have significant controls but in effect, does not. This is so because
although the legislation required is already in place it is not really
implemented. The government's task is therefore simpler and requires only
an implementation of those legal provisions.
The speaker next drew attention to 'two major issues'. The first concerned
the question of moving from a fixed to a floating exchange rate system.
He suggested that this would not by itself solve the problem. The concept
of equilibrium does not work because in the event of a devaluation, expectations
regarding that devaluation will make the rate higher. A floating exchange
rate offers no solution to the volatility generated by capital flows.
The second question was whether controls have to be permanent or not.
The major reasons cited for control are two. First, they will help the
domestic market by reducing the domestic interest rate, as has happened
in Malaysia. In the case of Brazil, one needs to wait and see whether
that will work. But it is the second reason that provides the need to
have permanent controls in Brazil, Carvalho argued. In Brazil, as in Mexico
and Thailand, the major problem with capital flows since 1998 is that
it is the residents who take funds out with them. These include not only
the rich but also the middle class, who are free to invest abroad through
foreign banks. The change in the nature and the greater potential for
damage of the capital flow problem has now made it imperative that the
controls be permanent. Political autonomy is also a must for these objectives.
Finally, capital controls must cover the plugging of investments abroad,
for which the law was already in place. Restrictions need to be imposed
on both inflow and outflow (on luxury spending abroad on the basis of
foreign exchange scarcity). Financial companies also need tight legislation
for stricter control of their investments abroad. Learning along the way
and coping with adverse public opinion are of utmost importance. Coping
with the increasing pressures from the IMF is another task the government
must train itself to do.
The last speaker, Ricardo Carneiro (UNICAMP), concentrated on the political
aspects of the issue under discussion. Carneiro, who has been a long-time
economic advisor to President Lula, pointed out the difficulties faced
by even a leftist government, of following a policy such as capital control.
The government could fix the interest rate but since it had no controls
over the exchange rate, this was discarded. There is, in reality, no autonomy
for macroeconomic management.
But this does not mean that Brazil has to live without a development path
in the absence of capital control. Brazil can try to exert some control
over the interest rate, though it is difficult. It can also use semi-economic
institutions for this purpose. In addition, the state, which has a tax-base
of 34 per cent of the population, can try to effectively allocate the
tax resources. The government can, as a matter of policy, hinder certain
types of systems, say outflows, by creating bureaucratic hurdles rather
than by obvious or direct policies.
Carneiro stressed the need for a gradualist approach towards achieving
the ends that a country like Brazil obviously needs to pursue. Given the
complications of the current predicament in which Brazil finds itself,
the speaker was keen to highlight the use of cautious methods that can
achieve the apparently impossible task of keeping the people and organizations
like the IMF happy at the same time.
The audience came up with detailed questions on many of the issues discussed—on
country experiences (especially in Asia and a comparison of that with
Brazil), on the validity of the Tobin Tax, on technical methods and measures
used for calculating income inequalities. Questions on President Lula's
apparently soft stand on economic appointments and policies in Brazil
dominated the afternoon session. The workshop generated a lot of interest
and discussion, some of which continued even afterwards, on the issue
of financial capital flows, which is a major concern for developing countries
today.